Commissioner Hester Peirce added herself to the list of SEC officials making sensible comments about the agency’s role in regulating cryptocurrencies. At the Medici conference in Los Angeles last week she revealed a nuanced view. Here’s some of what she said, per Axios:

“On a beach, you have a lifeguard…. but she’s not sitting with the sand castle builders,”

For years now many have pointed to the need for regulatory “sandboxes” wherein an innovator can obtain binding agreements from a regulator: e.g. “we (the regulator) will regulate you differently than the underlying law would otherwise require if you commit to sharing data or designing your project in a specified manner.” While that could lighten the compliance load for some folks in the ecosystem; it also creates risks that some projects will get prefferatory treatment and an unfair advantage over other projects or technologies.

Peirce’s preference to be a lifeguard over a sand castle architect is laudable. In general, it’s best that regulators only get involved in emergencies, when there are grave risks to consumers or investors that can only be addressed through the law. Regulators should avoid making legally binding pronouncements that dictate specifics about how consumer or financial technologies should be built. Cryptocurrencies are at a nascent stage where any action from regulators could create far reaching consequences for development and U.S. competitiveness.

We would like to see policymakers approach these new networks similarly to how the early internet was approached: hands off policy calibrated to encourage developer experimentation. We are glad to see Commissioner Peirce shares these sentiments. Be sure to read some more of what she said.

In a hearing yesterday before the House Appropriations Committee, SEC Chairman Jay Clayton was asked by Congressman Stewart to clarify his view on how regulatory oversight of cryptocurrencies could be split between the SEC and CFTC. He responded:

It's a complicated area. Because, as you said, there are different types of cryptoassets. Let me try and divide them into two areas. A pure medium of exchange, the one that's most often cited, is Bitcoin. As a replacement for currency, that has been determined by most people to not be a security.

Then there are tokens, which are used to finance projects. I've been on the record saying there are very few, there's none that I've seen, tokens that aren't securities. To the extent something is a security, we should regulate it as a security, and our securities regulations are disclosure-based, and people should follow those and provide the information that we require.

This is the clearest indication yet that the SEC does not view Bitcoin as a security. Though that may seem like a settled question to the cryptocurrency community, the commodity status of Bitcoin has not yet been set in stone by U.S. regulators.

We have seen some members of Congress suggest that Bitcoin be treated as a security, something we have argued against for years, so it is reassuring that the head of the SEC does not seem to believe that is appropriate.

Congressman Emmer stands up for cryptocurrency innovation and gets important regulatory clarification from the SEC.

In today’s hearing, Congressman Emmer (R-MN) had an excellent line of questioning for the Director of the SEC’s Division of Corporation Finance, William Hinman, on the subject of open blockchain tokens and regulation.

Hinman responded that the initial sale of a token is difficult to have without it being security issuance. But he also said that “it is certainly possible that there are tokens that would not have the hallmarks of a security.” He went on to specify what a token that doesn’t have those hallmarks might look like: “a token where the holder is buying it for its utility rather than investment, especially if it's a decentralized network in which it’s used with no central actors.”

This is exactly the right approach. As we just wrote yesterday and have been stressing since 2015:

A decentralized token may not be a security even if the token’s initial pre-sale did fit the test for securities issuance, and

The factors that distinguish a non-security token from a security are

usefulness and

decentralization.

It’s awesome to hear the SEC’s Director of Corporation Finance testify that they are looking at these issues with a similar perspective.

It was also a treat to hear Rep. Emmer standing up for open blockchain innovation during the hearing, suggesting that the assumption—from regulators and elected officials—that decentralized networks are only used for fraud or crime is as misguided as assuming, back in the time of Columbus, that the world is flat.

As Emmer said, “People tend to fear what they don’t know. If people sailing the oceans at the time of Columbus had believed the world is flat we wouldn’t have had the great discoveries of the New World.”

Under the European Union’s General Data Protection Regulation, companies will be required to completely erase the personal data of any citizen who requests that they do so. For businesses that use blockchain, specifically applications with publicly available data trails such as Bitcoin and Ethereum, truly purging that information could be impossible. “Some blockchains, as currently designed, are incompatible with the GDPR,” says Michèle Finck, a lecturer in EU law at the University of Oxford. EU regulators, she says, will need to decide whether the technology must be barred from the region or reconfigure the new rules to permit an uneasy coexistence.

As provocative as it may be to European regulators, the better conception may be to see the new law as incompatible with the reality of open blockchain networks. That is to say, the GDPR presumes that there will be central intermediaries that can ‘erase’ information, but the world is trending toward ever more decentralized and immutable technologies. While firms may alter their behavior to comply with the new law, decentralized networks are global and unowned and won’t change. The result of the law, then, may be that Europe is closing itself off from the future of the Internet to its detriment.

That said, we’re optimistic that our European friends will come to see that their legitimate privacy concerns are best addressed not through law, but through decentralizing technology itself. Open blockchain networks, cryptocurrency, and general encryption are the backbone of a new more secure and private Internet on which individual have more control over their data, and firms are less incentivized to track and spy on their users.

Congress is positive on cryptocurrency in new major economic report extensively citing Coin Center work.

The Joint Economic Committee of the Congress has submitted it’s 2018 Joint Economic Report. For the first time, the report includes a chapter on cryptocurrencies [PDF] that we are pleased to see is hopeful and positive about the effect these technologies could have on the U.S. economy:

The buzz surrounding digital currencies resembles the internet excitement in the late 1990s when people recognized technology companies could change the world. Many internet companies launched and their valuations took off in short order. Many failed, but a few succeeded spectacularly and challenged the conventional ways of doing business. For example, people considered GeoCities the “home page” for individuals and Yahoo bought the company for $3.57 billion in 1999.406 GeoCities had characteristics similar to Facebook today (or MySpace in the early 2000s), but it never came close to Facebook’s reach and remained unprofitable. A company that did eventually succeed is an online book retailer called Amazon.com, but along the way its price gyrated with stock splits and recessions.

We were also happy to see Coin Center’s work cited several times throughout the report. Our director of research Peter Van Valkenburgh was quoted directly on money transmission licensing and securities regulations for ICOs, which have been major issues for us over the last few years.

FinCEN raises major licensing problem for ICOs in new letter to Congress.

Nearly a year ago Coin Center released a report highlighting a looming ambiguity in FinCEN’s interpretation of federal anti-money-laundering laws: whether or not token sellers are money transmitters who are subject to the Bank Secrecy Act and need to do “know your customer” compliance with respect to their buyers, and arguing that any such interpretation would require formal rulemaking. We issued the report in part because we felt that the separate but related discussion over whether token sellers might be issuing securities had overshadowed this issue and left many unaware of the serious legal consequences that could stem from potentially violating the Bank Secrecy Act rather than the Securities Acts.

As it happens, our concerns were well-founded. Today FinCEN released a letter to Senator Ron Wyden clearly indicating that they interpret the relevant laws and regulations such that token sellers are money transmitters:

A developer that sells convertible virtual currency, including in the form of ICO coins or tokens, in exchange for another type of value that substitutes for currency is a money transmitter and must comply.

Make no mistake, this is a highly consequential interpretation. Accordingly, any group or individual developer who both (A) sold newly created tokens to buyers (i.e. had an ICO) involving U.S. residents and (B) failed to register with FinCEN as a money transmitter,and perform the associated compliance KYC/AML obligations, can be charged under a federal felony criminal statute, 18 U.S.C § 1960, with unlicensed money transmission. If found guilty one could face up to five years in prison. Criminal liability may also extend to employees of, and investors in, the business that sold the tokens.

There are important public policy questions at stake here:

Is it wise or appropriate under relevant administrative law to make this substantial change/clarification in interpretation through a letter to a member of Congress interpreting guidance, rather than a public rulemaking or new legislation?

Is it constitutional to mandate private data collection from people who are not financial intermediaries in the traditional sense, and may be better analogized to persons selling a new invention to buyers in a person to person transaction?

It is very difficult to take this letter and derive from it a clear picture of FinCEN’s interpretation. Only one footnote is given to explain their legal reasoning:

See, FIN-2013-G001 (explaining that convertible virtual currency administrators and exchangers are money transmitters under the BSA), and FIN-2014-R001, Application of FinCEN’s Regulations to Virtual Currency Mining Operations, January 30, 2014 (explaining that persons that create units of virtual currency, such as miners, and use them in the business of accepting and transmitting value are also money transmitters).

This footnote does not tell us whether FinCEN classifies these sellers as “exchangers” or “administrators,” two distinct types of money transmitter identified by the 2013 guidance. As we describe in our 2015 paper, there are compelling reasons why a developer selling a token is not an administrator: they cannot both issue and redeem the tokens that they sell, like a Bitcoin miner they merely put them into circulation and cannot claw them back (assuming they have sold an actual decentralized token and not some promise of future tokens). There are also good reasons why a developer selling a token is not an exchanger. They may sell but they do not do so as a business dedicated to exchange; they sell as one individual or entity would sell any valuable investment or commodity to another person, for their own purposes rather than to provide third-party money transmission services between two customers or people.

The bulk of the cited 2014 guidance on miners explains why a Bitcoin miner is not a money transmitter if they merely create the units. To be a money transmitter a miner must also sell them as part of an exchange business, rather than merely sell them on their own behalf. We can only assume that FinCEN believes that developers selling tokens are “in the business of accepting and transmitting value” in addition to creating new tokens. No doubt a developer selling tokens is accepting value, but who are they transmitting it to aside from themselves?

This is a complicated and consequential legal interpretation, and one that should be discussed, unpacked, and eventually finalized in a more formal and transparent setting, e.g. a rulemaking. A footnote in a letter to a Congressman should not suffice.

Common understanding suggests that money transmission is an act performed by an intermediary, a person who stands between two parties accepting money from one and transmitting it to another. When a person transacts directly with another person, giving them money for any reason—as a gift, a payment, a donation, a grant, a tip—she does not play this intermediary role. She does not hold herself out as a trusted third party. She is engaged in private, personal transactions rather than being engaged as a third party to the transactions of others.

Deputizing third-party intermediaries to surveil their users on behalf of the government is a policy choice Congress made long ago; one that carries risks to individual privacy but also potential benefits to national security and peace. It’s a tradeoff Congress made back in the 1970s and it isn’t going away anytime soon. However, mandating the same kind of surveillance from individuals who are not intermediaries—who are merely transacting on their own account with another citizen—is a considerable recalibration of the balance between privacy and security. It tips the scales against personal privacy and may even be unconstitutional.

This is not a recalibration that should be made merely by issuing administrative rulings or guidance, the approach thus far taken by FinCEN when dealing with these questions. Instead, FinCEN should clarify that selling decentralized virtual currency on one’s own account does not constitute money transmission, regardless of whether the purpose of that sale is to pay a merchant, to sell tokens received through mining, or—indeed—to sell one’s own newly invented decentralized token.

Should FinCEN or Congress wish to regulate this activity for financial surveillance purposes, that change must be the subject of a larger, more public debate within a notice and comment rulemaking or an amendment to the statutory law itself. Only those formal processes can enable necessary debate over financial surveillance and the constitutionality of warrantless search.

These members of Congress are applauding the CFTC and SEC’s light touch approach to cryptocurrencies.

Reps. Jared Polis and David Schweikert, co-chairs of the Congressional Blockchain Caucus, along with Rep. Tom Emmer, sent a letter to CFTC Chairman Christopher Giancarlo and SEC Chairman Jay Clayton praising both agencies’ measured response to rise of open cryptocurrency projects. They also tell the agencies not to overlook the massive potential of crypto beyond money and speculation:

As you develop your approach, we encourage you to think not only about the fluctuations of cryptocurrency prices today, but to focus on the future potential of this groundbreaking technology and its role in maintaining our leadership role in technological innovations. Any legislation or regulation should be simple, clear, and narrowly tailored to specific applications of the technology that raise policy concerns, thus allowing innovation in this space to be guided by consistent and predictable guard rails without imposing undue burdens.

We agree with the Representatives’ assessment and are pleased to see responsible approaches to innovation coming from federal policymakers and regulators.

The volume on Bitcoin in DC has recently been turned up to eleven. As we saw from this week’s hearing, Federal regulators have their eye on cryptocurrencies. Coin Center has been working with federal policymakers for a while now, helping them understand the value of protecting and fostering this technology. Here are some podcasts that will update you on our work:

On the Cato Institute’s podcast Coin Center executive director Jerry Brito discusses what renewed regulatory interest in cryptocurrencies means for the technology and what Coin Center is doing to respond.